Will Net Neutrality Cost More Than Cable?

NEW YORK (TheStreet) -- Advocates of "net neutrality" say the issue is about user freedom. Opponents say it's about property rights. (Net neutrality treats all data on the Internet the same, so no one can pay or charge extra to get priority treatment for certain data.)

Both frames are false. The truth is that, since the Web was spun, there has been a growing cost disconnect between its core and its edge.

Companies like Google (GOOG) represent the core. In building scaled data centers, they take full advantage of Moore's Law, which predicts that the number of transistors on an integrated circuit will double every two years -- which has been the case since 1965. They also took full advantage after Wide Division Multiplexing let companies dramatically increase the capacity of optical fiber by changing the electronics at each end of a line.

In my book on Moore's Law, I discussed this. A glut of fiber entered the market in the late 1990s, but WDM let that fiber carry much more traffic at the same cost -- orders of magnitude more. There was no way for anyone, not even Enron, to corner such a market.

A lot of fiber went dark as a result, costing more to "light" than it was worth. Google and a few other companies came in early the next decade to scoop up the bargains. As a result, the cost of moving data across long distances has plunged by 90% just since 2007.

While the core Internet has been able to take full advantage of Moore's Law, the edge has not. This is not because edge technology hasn't improved. It has. By adding fiber within their networks, by supporting WiFi and by shortening the distances signals travel over copper, cable and phone monopolies have brought faster speeds without big price increases.

But when you run fiber, you have to send out trucks with people. When you repair fiber, you have to do the same. When you add customers, you also have to roll trucks. Trucks and people are not subject to Moore's Law. Their cost keeps going up.

While the 1996 Telecommunications Act foresaw the edge as a competitive market, with re-sellers buying and distributing bandwidth in competition with infrastructure owners, cable and phone companies basically had those rules repealedduring the Bush years, creating effective duopolies in most U.S. markets.

This has limited the profit impact of cost differences between the edge and the core. Phone and cable companies have maintained their prices by adding "services" to their bundles. While net neutrality advocates like to predict that edge companies are about to charge sites for carriage, the money actually flows the other way, from edge ISPs to content companies.

Services like "TV Everywhere," which I wrote about last month, let cable networks buy much more content than they can ever show, and charge consumers for it in their Internet bills. Combining content with service is the means by which edge ISPs hope to reduce "cord cutting" and maintain profitability in an age of rising truck costs.

So far, it's working, both for big content companies and edge ISPs. The best example is Comcast (CMCSA), which is both an edge ISP and a content company. Its stock has risen 271% in the last five years, even more than Google's 248%.

Services like Netflix (NFLX), Amazon (AMZN) Prime and even Google's YouTube threaten this cozy relationship. Each can deliver consumers a wealth of content for literally pennies per day. My cable-Internet bill from Comcast comes to more like $7 per day.

These services use the economics of the core Internet. Those costs continue to come down. Comcast, and companies like it, are stuck with the costs of the Internet edge.

All this comes out in arguments over "peering," the traditional Internet business model for moving data between networks.

Spurred by the U.S. Court of Appeals' takedown of the FCC's net neutrality rules in Verizon v. FCC, some edge ISPs have been slowing streams from competitors like Netflix and Amazon.

What they want are new financial arrangements for "peering," in which core companies like Netflix help pay for edge costs. This despite the fact that Netflix itself has been working to reduce edge ISP costs through the creation of a Content Distribution Network under open source standards, essentially making downloads a local call.

The trouble is, of course, that the cost of that local call keeps going up.

CDNs have been around since the last century, with companies like Akamai (AKAM) providing local caching that delivers core services closer to customers. Google also provides redundancy, both through its own data centers and "Google in a Box," delivering software and services at corporate premises.

But caching doesn't reduce the cost of running trucks or hiring cable guys to connect new customers or fixing lines that come down in a storm.

All this is in the hands of the FCC. They have a lot of goals, most of which have nothing to do with the present dispute.

The FCC wants to maintain subsidies for rural networks, which it calls "universal service," it wants to keep old phone services like 911 intact and paid for. It's willing to replace the old phone industry rules with new regulations that all Internet companies will have to follow.

Competition, in the form of wholesaling of capacity and interconnections, is said to be among the "conditions and presumptions" of the agency. But the result is almost certain to be a shifting of costs from the edge providers, which have been subject to regulation by the FCC for over a century, to those in the core, which have been kept unregulated up until now.

Whether you call the present conflict one over "peering" or net neutrality, here is the bottom line:

The government wants Internet providers to maintain old phone industry services, costs and business arrangements. But the Internet was designed to sidestep these things.

Cable operators want to guarantee that their profitable control over customers and content is protected.

Core Internet services want unrestricted access to consumers in order to keep growing.

The arguments over growth and gatekeepers come down to a question of who will pay the costs of the edge and what they will get for that. Google has learned what those costs are in its Google Fiber experiment in Kansas City.

In the process Google has changed its stance on net neutrality, denying consumers the power to run servers off their home lines, and citing the experience of other edge companies in doing so.

Even Google acknowledges that bearing the costs of the edge should give the edge some power.

It's no longer a question of whether consumers and core Internet companies will surrender on net neutrality, but how much they will be forced to give up.

At the time of publication, the author held no positions in any of the stocks mentioned.